IP: The bare facts on naked licensing

Companies that license their trademarks should be aware that their licensed trademarks may be declared abandoned and unenforceable if they engage in what is known as “naked licensing.” Naked licensing occurs when a licensor fails to exercise adequate quality control over a trademark licensee’s use of the licensed trademark. When courts find naked licensing, the nearly inevitable result is a judicial declaration of trademark abandonment.

Case in point, the recent decision in Eva’s Bridal Ltd. v. Halanick Enterprises, Inc. provides a cautionary tale for trademark owners regarding the rigid manner in which the naked licensing rule is often applied. In this case, the 7th Circuit affirmed a district court’s finding of trademark abandonment due to naked licensing, thereby blocking the trademark owner’s infringement suit and invalidating its trademark, which had been in continuous use by the trademark owner and its predecessors in interest for nearly 50 years.

The mark at issue in Eva’s Bridal was first used in 1966, when Eva Sweiss opened a bridal shop in a suburb of Chicago under the EVA’S BRIDAL mark. The business was successful and, over the years, Ms. Sweiss’ children were permitted to open additional EVA’S BRIDAL shops under license in a few locations in the Chicago suburbs. The business was eventually transferred to Nancy Ghusein (nee Sweiss) and her husband, who continued the practice of licensing the EVA’S BRIDAL mark to family members. The owner of Halanick Enterprises was one such family member, who entered a trademark license agreement and paid $75,000 per year for use of the EVA’S BRIDAL mark. In 2002, Halanick’s written license agreement with Eva’s Bridal Ltd. expired. Rather than seek to renew the license, Halanick ceased royalty payments but continued using the EVA’S BRIDAL mark in connection with its business. The plaintiff eventually sued Halanick in 2007 for trademark infringement in district court.

Halanick raised laches and naked licensing defenses. Without deciding Halanick’s laches defense, the district court held plaintiff’s mark was abandoned due to naked licensing. Specifically, the license agreement between plaintiff and defendant failed to place any quality control requirements on the defendant’s operation of the store and provided the plaintiff with no power to supervise or control the defendant’s business under the EVA’s BRIDAL mark. Moreover, the plaintiff apparently admitted that, in practice, it failed to assert any controls over the defendant’s use of its mark. The district court dismissed the case, permitting the defendant’s continued unlicensed use of the mark without royalty payments.

On appeal, the plaintiff argued that formal quality control measures were unnecessary in this circumstance because plaintiff was familiar with the high standards defendant employed in the operation of the business and plaintiff and defendant sold high-quality dresses from the same designers. The 7th Circuit was not impressed, noting that these arguments failed to address consumers’ interests in the quality of service provided by the defendant’s bridal shop bearing the EVA’S BRIDAL mark, services which plaintiff had failed to monitor and control.

Moreover, the court guided that plaintiff’s focus on defendant’s provision of “high quality” goods and services was misplaced, stating that, under the trademark laws, “proprietors need not ensure high quality goods.” Instead, “the sort of supervision required for a trademark license is the sort that produces consistent quality [not necessarily high quality].” This is so because a “trademark’s function is to tell shoppers what to expect - and whom to blame if a given outlet falls short.” The touchstone of quality control is ensuring consistency in meeting consumers’ expectations for the brand.

But how much control should be asserted to avoid a finding of naked licensing? The court only commented that it depends on the surrounding circumstances and, in this case, the plaintiff admitted that it exercised no quality control, making the court’s conclusion that the license was a naked license nearly inevitable.

The court was concerned that a consumer who visited plaintiff’s Eva’s Bridal shop and defendant’s Eva’s Bridal shop “might not find a common ambiance or means of doing business,” despite the stores’ use of the same trademark. The language “might not” signal an important point regarding the quality control requirement. Courts that declare trademarks abandoned due to naked licensing generally do not attempt to evaluate whether the trademark has actually lost its ability to function as a mark in the marketplace. Instead, the courts evaluate whether the license itself provided for sufficient quality control and/or whether, in the court’s view, sufficient control was exercised by the licensor—end of analysis. There is generally no inquiry into whether the licensee’s goods and services were, in fact, consistent with consumer’s expectations for the brand. If the licensor allowed the possibility of a lack of consistency to exist through inadequate quality control, that is enough for a finding of naked licensing.

In Eva’s Bridal, there seems no doubt that the plaintiff engaged in naked licensing. However, it is less clear whether the severe result of trademark abandonment should always be applied in such circumstances. In the Eva’s Bridal scenario, the EVA’S BRIDAL mark was used for nearly 50 years by various members of a family in a few suburbs of Chicago. Due to the longstanding use of the mark in a small geographic area, it is possible that consumers would know or assume that the EVA’S BRIDAL mark indicated a single source, namely, the licensor. If so, then the mark should have trademark significance and a court’s finding that it was abandoned may be counterfactual.

Moreover, it is unclear how declaring the mark abandoned does anything but increase the risk for consumer confusion going forward. Oddly, the court held plaintiff’s trademark abandoned for naked licensing because plaintiff’s and defendant’s stores might not have “a common ambiance or means of doing business,” yet the court’s decision, which permits defendant’s continued unlicensed use of the mark, does nothing to prevent that very result. After all, the court’s finding of abandonment leaves two bridal shops in the Chicago suburbs bearing the name EVA’S BRIDAL that may operate completely independently of one another. This formalistic and rote application of trademark abandonment due to naked licensing seems at odds with other inquiries of law and fact under the trademark laws, where actual consumer perception and confusion are generally the most important considerations. In any event, a finding of naked licensing typically carries with it this harsh result.

Companies can avoid this trap by ensuring that written agreements to license their marks contain robust quality control provisions. At a minimum, these provisions should clearly place control of the mark in the hands of the licensor, require the licensee to maintain a consistent quality of goods and services and permit the licensor to monitor quality through inspections and other supervisory activities. In addition, the agreement should allow the licensor to terminate the license if the licensee fails to meet quality standards or obstructs the licensor’s attempts to monitor quality. In the event that quality control and naked licensing ever become an issue in litigation, the licensor will be happy to have maintained a record of its active, regular and consistent efforts to monitor and control its licensees’ uses of its mark.